Every investor loves to build a portfolio before investing in any asset. In order to diversify your portfolio, an investor built an Asset allocation model. Asset allocation models focus on strategic planning and diversification. It basically refers to the investment strategy of balancing risk and reward by determining what percentage of the portfolio or net worth to put in various asset classes. There are different asset classes such as stocks, bonds and cash. The process of determining which asset one holds on what proportion is totally a personal one. The asset allocation that works best for you depends upon time horizon and your ability to risk. There are basically two types of asset allocation:
- Strategic Asset Allocation
- Tactical Asset Allocation
Strategic Asset Allocation: It is the traditional approach which basically means holding a diversified portfolio and not changing your allocation based on asset allocation. It is completely aligned to investor objectives and risk. It doesn’t take into the account of any positive and negative news of asset class performance in near future.
Tactical Asset Allocation: It is modern approach of investing in which an investor invests in mainly three classes mainly stocks, bonds or cash. It is based on relative asset class performance. Short term adjustments in asset allocation are frequently made so that portfolio can earn higher returns and beat the performance of benchmark index. Entry and exit into asset classes and exit from investments have to time correctly.
These allocations will be totally based upon what kind of investor one is. There are basically three types of allocation:
- Conservative Investor:
These types of investors want modest income and capital growth with reasonable capital preservation. Such investors are easy with moderate fluctuations in the value of their investments and plan to hold their investment over the medium to long term for at least 5 to 7 years. They basically invest in fixed income securities and other hard assets. Returns on these investments are low as there is hardly any risk. Typically, a conservative investor values protecting the principle over seeking appreciation.
- Moderate Investor:
A moderate investor values higher long term returns and is willing to take considerable risk. They are comfortable with short term fluctuations in exchange for seeking long term appreciation. Apart from that, the moderate growth investor is willing to endure large short-term losses of principal exchange for the potential growth investor.
- Aggressive Investor:
An investor with an aggressive style of investing will loves to maximize your returns and is willing to accept the substantial risk. They firmly believe that maximizing the long-term returns will be more important and ready to take the risk. They may endure extensive volatility and significant loss.
Bottom Line:
The strategic asset allocation is quite different from the tactical asset allocation, while the first one focuses on the how you move your money in and out of investment categories, while the tactical asset allocation approach is how you move money in and out of the investment category. It requires more expertise and there is no guarantee that it will deliver returns.
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